Daily Times

Economist, entrepreneur and my good friend Osman Niazi has a hypothesis on the mismatch of four to five-year terms of elected governments’ democracy versus the ten-year term of long-term debt (credit) in countries like Pakistan. According to the hypothesis, politicians do not focus on sustainable long-term economic policies because their tenure is shorter than that of the borrowing they do to rollout their programmes and policies. Thus, representative governments on the one hand have failed to carry out long-term reforms and, on the other, form policies that lead to economic meltdowns on a regular basis. This hypothesis is one of many that links credit maturity periods to socio-economic events. And empirical evidence strongly backs such hypotheses.

Credit maturity of a given credit cycle is actually a very good precursor to a lot of financial and social events of significance in this day and age. For example, take the ‘Greenspan Put’ of 1987 in which former Federal Reserve (FED) Chairman Alan Greenspan ensured an almost free supply of credit to the US economy (and ultimately global economy) after the 1987 stock market crash. Long-term credit maturity (the period when the debt matures) in the US ranges from 10 to 30 years. Almost 20 years after the introduction of the Greenspan Put, the global economy faced its biggest financial crisis since the Great Depression. Interestingly, 20 years is also the maturity term for most mortgage debt in the US, an asset class to which most of this nearly free credit went.

If one looks at this cycle of credit maturity it helps explain why almost all dictatorial regimes in Pakistan came down crashing around the 10-year mark. These regimes, as a policy, rely on soothing the urban and middle classes, and provide stimulus to the economy through the injection of credit. Without the production base to absorb surplus credit, it almost always goes into bubble sectors ranging from non-competitive industries in the 1960s to real estate in the 1980s and 2000s. This type of credit, in the case of Pakistan, is usually acquired from foreign sources and has a maturity period of seven to 10 years. So, when one credit cycle ends most of the planners do not realise that it has to be replaced with another credit cycle of the same magnitude. And even if they do, usually much further down the line, refinancing a stimulus of the same magnitude as the first becomes harder. Thus, around the seven-year mark, discontent starts growing in the urban and middle classes of the country that leads to the ultimate collapse of the regime.

All such crises and collapses have economic, political and social consequences. The impact of the maturity of a credit cycle, thus, puts serious questions not only around the criterion to judge government policies but also around the holy grail of central bank autonomy. If credit supply and credit cycle issues have intense political and social ramifications, the decisions regarding them cannot be taken looking at short-term financial and monetary considerations only. Europe and the US are learning this the hard way these days with calls for more oversight of the FED in the US and calls for taking into account socio-political considerations while pursuing policies like austerity in Europe.

With this evident impact of the credit cycle on economies, governance and societies, the challenge of governance in any society is to link governance and policymaking with credit cycle maturity. And here lies the real challenge for policy planners. In a world where the fast pace of technological innovation requires more nimble policy making, contrary to long-term Soviet style policy planning, devising policy criteria based on a credit cycle maturity period while ensuring more nimble policymaking poses a real challenge to politicians and policymakers. This is uncharted territory for us humans and no governance model has ever been exposed to this challenge that has the potential to lead to extremely volatile consequences. Meeting this challenge is essential for stability in our world.

So how do we meet it? For one, the governing units need to be smaller and more homogeneous. This makes it easier to balance economic interests within the unit. The smaller size will also ensure limited impact of policy blowback. Secondly, there needs to be political oversight or an input mechanism for defining monetary policy. This has to be achieved while maintaining separation of monetary and fiscal policy. Having smaller governing units dealing with development, policy planning and fiscal issues gives the flexibility to an elected federal government to be a fair contributor in monetary policy issues. This exercise also requires a clear perspective on ensuring the creation of self-sustaining governing units as the ultimate goal. The need to create self-sustaining governing units must also be balanced with security and international trade compulsions. This is easier said than done and a lot of trial and error will go into devising a workable mechanism. In the coming years, many nation states will attempt to achieve the balance between more nimble policy planning and the longer term impacts of credit maturity cycles. As this is an exercise in progress, one thing is for certain: the one who nails it will be the thought leader of this century.

The author can be reached on twitter at @aalimalik